Renaissance: Rails, Returns, Capital & Capacity Anthony B. Hatch – abh consulting 155 W68th Street NYC 10023 (212) 595-0457 [email protected]:: Indiana Logistics Summit November 14, 2006

Railroads at historic tipping point          Capacity issues across all modes Volume increasing Share increasing Rates increasing Services levels (yes) increasing Returns increasing A

secular

, not a cyclical story Capacity and infrastructure – and competitor - issues remain

Not fully reflected in the market?

Show Me the Money  Share Price is

the

Indicator – over time!

 Cash (Flow) is King  High ROIC = High Stock Price  And Vice Versa  Key is the phrase “through a cycle”  Old Model: Disinvestment  New Model: TBD

Spending $: Mgmt.’s #1 Decision  Capex for Maintenance – “base”  Capex for Capacity, Service & Growth  Dividends  Share Buybacks  M&A – Strategic  M&A – Non-strategic (conglomeracy) 

How management allocates indicates confidence & direction and impacts all stakeholders

Virtuous Circle 2006  Better returns (half

finally

equal to the cost of capital) earn returns  Better stock prices  Better revenue prospects – up double digit ’04-05  Equals more investment – capex up sharply   Equals more capacity, better service …equals better returns and growth….

Railroad Stock Prices January 2001 – October 2006 Index Jan 2001 = 100

450 400 350 300 250 200 150 100 50 0 01 Jan 01 July 02 Jan 02 July 03 Jan 03 July 04 Jan 04 July 05 Jan 05 July 06 Jan 06 July S&P500 BNI CSX NSC UNP CNI CP

Sources: MSN and CSI, Inc.

S&P 500 and Railroads Monthly Data January 1980 – October 2006

Index Jan. 1980 = 100 1400 1200 1000 S&P500 800 600 400 200 0 Jan-80 Jan-85 Railroads Jan-90 Jan-95 Jan-00

Sources: MSN and CSI, Inc.

Jan-05

Even With Booming Traffic, Rail Earnings Are Substandard Median Return on Equity in 2005 (S&P 500 companies)

Oil & Gas Pharmaceuticals Chemicals Autos & Parts All Industries Railroads* Electric Utilities Forest Products 12.3% 11.3% 10.3% 18.7% 16.9% 16.1% 24.9% 28.4%

*BNSF, CSX, NS, and UP Source: Business Week

RR CoC vs. ROIC -stocks have done well but… they still trade at a discount to all stocks

20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 81 Cost of Capital 84 87 90 93 96 Return on Investment 99 02 05

Source: Surface Transportation Board

Railroad Capital Expenditures Class I Railroads Billions

$10 $8 $6 $4 $2 $0 80 82 84 86 88 90 92 94 96 98 00 02 04 06

e Source:

Railroad Facts

, AAR

Capital Expenditures as % of Revenue

Food – 2.6% Transportation equipment – 2.8% Petroleum & coal products – 3.0% Wood products – 3.0% Fabricated metal products – 3.5% Average all manufacturing – 3.5% Chemicals – 4.4% Paper – 4.7% Nonmetallic mineral prod. – 5.4% Electric utilities – 11.6% Class I RRs – 17.8%

Source: Census Bureau, EEI, AAR

Railroad Performance Class I Railroads Index 1981 = 100

300 250 200 150 100 50 0

Productivity Volume Revenue Price

64 68 72 76 80 84 88 92 96 00 04

Source:

Railroad Facts,

AAR

Railroads and the Economy Class I Railroads Index 1980 = 100

250 200 150 100 50 0 Industrial Production Rail FCS Carloads 80 82 84 86 88 90 92 94 96 98 00 02 04

Sources: Federal Reserve System and AAR

Railroads and the Economy Class I Railroads Index 1980 = 100

250 200 150 100 50 0 Industrial Production Rail Ton-Miles 80 82 84 86 88 90 92 94 96 98 00 02 04

Sources: Federal Reserve System and AAR

Railroads and the Economy U.S. Railroads Index 1980 = 100

500 400 Industrial Production Rail Intermodal 300 200 100 0 80 82 84 86 88 90 92 94 96 98 00 02 04

Sources: Federal Reserve System and AAR

Railroad Intermodal Revenue Growth Over 5% - Long Live the New King!

$14 $12 $10 $8 $6 $4 $2 $0 1990 1995 2000 2005 .

Coal Intermodal Source: Carload Waybill Statistics (includes non-Class I railroads)

Intermodal Growth Drivers Domestic

and

International  Globalization  Trade  Railroad Cost Advantages  Share Recovery From Highway  Truckload Issues

Serious U.S. Transportation and Congestion Problems     High Cost of Highway Maintenance and Construction Interdependence of Modes $67 billion per Year Drag on Economy Demand for Freight Transportation to Double by 2020

Coal and Ag – Bulk Comeback  New growth mode?

 Emissions and environmental issues  Oil prices and coal  Politics and coal; and grain/rereg  Ethanol  Exports  Feed

Major Sources of Railroad Revenue Class I Railroads, 2005 Gross Freight Revenue in billions Intermodal* - $10.1

Coal - $9.4

Chemicals - $5.4

Transportation equipment - $4.0

Farm products - $3.6

Food - $3.3

Lumber & wood - $2.3

Pulp & paper - $2.0

Primary metal products - $1.7

Stone, clay & glass products - $1.5

Nonmetallic minerals - $1.3

0% 5% 10% 15% 20% 25% 30%

Source: AAR *Estimated. Some intermodal revenue is also included in individual commodities.

Railroad Rates- the old story Class I Railroads, Revenue Per Ton-Mile Cents

6 5 4 3 2 1 0

Constant $: Down 56% since 1980 Current $: Down 9% since 1980

80 82 84 86 88 90 92 94 96 98 00 02 04

Source:

Railroad Facts,

AAR

Pricing - the new paradigm      Rates up 3% in ’04 – post-Staggers best

Up 11%

in ’05 (Secular rate of 2-3%?) Fuel surcharges similar to TL Yet Price Gap to the highway

widening, even in ’05 and ’06 YTD

Capacity (still) short across all freight modes, despite temporary surpluses  Rails moving toward tariff and spot markets Conclusion:

Best Ever Rate Environment

“The new Golden era” – cost of capital

within sight

; not there yet

RRs and Investment  Is growth affordable? Capex up 10% in ’07?

 Can the intermodal model extend to carload?

  Is additional capacity necessary? Desirable?

Wall Street’s constrictive role (“fighting the last war”) –

changing?



Is this disconnect between the Renaissance and the Street the opportunity of a lifetime?

Sources of capital  FCF – booming at most carriers (capex vs. ROIC)  Governments – states, PAs, Feds  Governments – Canada as contrast  Traditional Street sources & Banks  Private Equity

Railroad Issues Fall 2006            Economic/industrial recovery - durability

Service metrics

– recovery or a meltdown (again)?

Trucking troubles also a

secular

issue Capacity – coming shortage?

Or “creative tension”?

Intermodal – new king of the hill Coal and Grain: Comeback? Thanks to oil!

Is Growth Affordable?

(Who will pay?) Alliances vs. Mergers?

Hurricanes, other AoG Labor – 1 Man Crews off the table? Coming shortage?

Safety and security – new risk?

ABH Consulting Anthony B. Hatch

155 W. 68th Street New York, NY 10023 (212) 595-0457 [email protected]

“Big Six” Rail H106 results  All six beat Street consensus  EPS up an average 58% vs. tough comps; range from +27% to +140%  Revenue growth averaged 14%  Estimated Yield growth (ex FS) was 6%  Fuel surcharges added another ~6% 

So Far Q306 5 for 5 beating Street; solid forecasts (DPS increases, share buybacks & splits) – operating ratios in the 50s?!?

Capital Expenditures 2005 Class I Railroads $6.4 billion for Roadway & Structures and Equipment

TOFC/COFC Terminals 2% Public Improvements-Const. 2% Computer Systems & WP 2% Freight Cars Grading 3% 3% Bridges, Trestles & Culverts 6% Signals and interlockers 8% All Other 11% Rail & Track Material 26% Locos 9% Ballast 10% Ties 18%

Source:

AAR and R-1 annual reports Excludes new operating leases.

New Freight Car Deliveries Railroad and Private Owners

80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

Beginning 1995, Canadian cars included with U.S.

New Locomotives Installed U.S. Class I Railroads

1200 1000 800 600 400 200 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

Note: New locomotives may also be installed by Canadian, Mexican, or U.S. regional railroads.

Return on Total Capital by Industry 2001-2004 average

14.3% 5.2% 6.0% 7.3% 8.7% 8.9% Auto Railroad Hotel Trucking Airline Package Delivery

Railroad Return on Equity Class I Railroads

14% 12% 10% 8% 6% 4% 2% 0%

n.m.

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05

n.m. - not meaningful (negative value) Source:

Railroad Facts

, AAR

Railroad Employee Productivity Class I Railroads, Ton-Miles Per Employee Millions

12 10 8 6 4 2 0 80 82 84 86 88 90 92 94 96 98 00 02 04

Source:

Railroad Facts

, AAR